When economists refer to capital, they are referring to the assets–physical tools, plants, and equipment–that allow for increased work productivity. Capital comprises one of the four major factors of production, the others being land, labor, and entrepreneurship. Common examples of capital include hammers, tractors, assembly belts, computers, trucks, and railroads. Economic capital is distinguished from financial capital, which includes the debt and equity accumulated by businesses to operate and expand.
Key Takeaways
- In economics, capital refers to the assets–physical tools, plants, and equipment–that allow for increased work productivity.
- By increasing productivity through improved capital equipment, more goods can be produced and the standard of living can rise.
- The four major factors of production are capital, land, labor, and entrepreneurship.
The Economic Role of Capital
Capital is unlike land or labor in that it is artificial; it must be created by human hands and designed for human purposes. This means time must be invested before capital can become economically useful. For example, the fisherman who fashions himself a rod must first divert time from other activities to do so.
In this sense, capital goods are the foundation of human civilization. Buildings need to be built, tools crafted, and processes improved. By increasing productivity through improved capital equipment, more goods can be produced and the standard of living can rise. Capital goods are also sometimes referred to as the means of production because these physical and non-financial inputs create objects that can eventually be bestowed with economic value. The economist Adam Smith defines capital as, “that part of man’s stock which he expects to afford him revenue.”
Goods vs. Money
Ever-improving capital is important because of what follows its production: cheaper and more bounteous goods. Note that money is not included among the factors of production. While money facilitates trade and is an effective measure of a good’s value, individuals cannot eat, wear, or be sheltered by money itself. The ultimate aim of economic activity, work, and trade is to acquire goods, not money. Money is a means to afford goods. Better capital goods allow people to travel farther, communicate faster, eat better foods, and save enough time from labor to enjoy leisure. Many countries have printed and inflated their way into poverty by losing focus on savings, investment, and capital equipment in favor of increasing their money supply by printing more of their currency.
Capital Goods Production Process
Before a factory can be built or a car can be manufactured, someone must have saved enough resources to be able to survive the production process. This involves forgoing present consumption in favor of greater future consumption.
Every capital production process starts with savings. Savings help by generating investments. Investments eventually lead to finished goods and services. Traditionally, it is the role of the capitalist to first save and then assume risk by employing people in production processes before revenue is generated from the finished goods. All of the factors of production interact with one another. Natural resources are transformed into capital goods by human labor and subjected to market risk through entrepreneurial activity.
Each factor of production is able to contribute to production processes and earn an income based on its use. The income for land is usually called rent. Labor receives wages. Employed capital goods and equipment receive interest, normally through their investment. Successful entrepreneurs receive profits.